Quality in Supply Chain Encroachment

TLDR

When quality is exogenous, encroachment can improve retailer outcomes. The study examines how endogenous product quality and heterogeneous customer preferences affect outcomes in a supply chain with manufacturer encroachment. We analyze a supply chain model where the manufacturer can adjust quality endogenously while customers differ in quality preferences. When quality is endogenous, encroachment always harms retailers, higher quality costs hurt retailers without encroachment but can help them with encroachment, manufacturers favor selling high‑quality products directly, and quality differentiation does not uniformly benefit either side—explaining retailers’ typical resentment of encroachment and cautioning firms against using differentiation to ease channel conflict.

Abstract

We study a supply chain with manufacturer encroachment in which product quality is endogenous and customers have heterogeneous preferences for quality. It is known that, when quality is exogenous, encroachment could make the retailer better off. Yet, when quality is endogenous and the manufacturer has enough flexibility in adjusting quality, we find that encroachment always makes the retailer worse off in a large variety of scenarios. We also establish that, while a higher manufacturer’s cost of quality hurts the retailer in absence of encroachment, it could benefit the retailer with encroachment. In addition, we show that a manufacturer offering differentiated products through two channels prefers to sell its high-quality product through the direct channel. Contrary to conventional wisdom, quality differentiation does not always benefit either manufacturer or retailer. Our results may explain why, despite extant theoretical predictions, retailers almost always resent encroachment. These findings also suggest that firms must be cautious when adopting quality differentiation as a strategy to ease channel conflict caused by encroachment.